Principles of Macroeconomics

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.title[
# Principles of Macroeconomics
]
.author[
### ECO 2307
]
.date[
### <em>Spring 2023</em>
]

---

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# Chapter 10
## Economic Growth, the Financial System, and Business Cycles

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## Long-run Growth

.panelset.sideways[
.panel[.panel-name[Intro]

**Strong vs. weak economy**
- meaning
- causes
- long-run vs. short-run

**Long-run economic growth**: 
- the process by which rising productivity increases the average standard of living
- Not short run swings in the economy inherent to the **business cycle**
- Real **GDP per capita**: The amount of production in the economy, *per person*, adjusted for changes in the price level.

]
.panel[.panel-name[Growth]
<img src="data:image/png;base64,#images/fig_10_1.png" width="75%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Prosperity]
.pull-left[
<img src="data:image/png;base64,#images/fig_10_1a.png" width="100%" style="display: block; margin: auto;" />
]
.pull-right[
<img src="data:image/png;base64,#images/fig_10_1b.png" width="100%" style="display: block; margin: auto;" />
]
]
.panel[.panel-name[Calc Growth Rates]
The growth rate of an economic variable like real GDP or real GDP per capita is equal to the percentage change from one year to the next.
- In 2019, Real GDP was $19,092 billion
- In 2020, Real GDP was $18,423 billion

$$
\Big(\frac{\$18,423 \text{billion}-\$19,092\text{billion}}{\$19,092 \text{billion}}\Big)\times100=-3.5\%
$$
]
.panel[.panel-name[SR Growth Rates]
Over periods of a few years, we can average the growth rates to find the approximate annual rate of growth.
- In 2018, real GDP growth was 3.0%
- In 2019, real GDP growth was 2.2%
- In 2020, real GDP growth was -3.5%
- So, the average annual growth rate over this 3-year period was:

$$
\frac{3.0\% + 2.2\% - 3.5\%}{3}=0.6\%
$$
]
.panel[.panel-name[LR Growth Rates]
For longer time periods, we wouldn’t want to calculate each of the annual growth rates and then take an average in order to find the average annual growth rate

Instead we would solve for the growth rate g, where:

$$
\textit{Previous real GDP} \times (1+g)^t = \textit{Current real GDP}
$$
with *t* representing the number of time periods between the previous and current periods.

*Rule of 70* can help us determine how long it will take for an economic variable to double: `$\text{Number of years to double} = \frac{70}{\text{Growth rate}}$`

If the growth rate is 5%, the variable will double in `$\frac{70}{5}=14$`

]
.panel[.panel-name[LR Growth Determinants]
**Labor productivity**
- Increases in real GDP per capita rely on increases in *labor productivity* 
- The quantity of goods and services that can be produced by one worker or by one hour of work

Why can the average American consume more than eight times as many goods and services now than in 1900?

What determines the rate of long-run growth?

What determines labor productivity growth?

]
.panel[.panel-name[Labor Productivity Growth]
1. Increases in *capital* per hour worked
    - **Capital**: manufactured goods used to produce other goods and services
    - **Human capital**: the accumulated knowledge and skills workers possess
    - The *more capital* a worker has available to use the *more productive* he or she will be
2. Technological change
    - Improvements in capital or methods to combine inputs into outputs (i.e. new technologies) allow workers to produce more in a given period of time.
    - The role of entrepreneurs here is critical 
    
3. Property rights
    - A market system cannot function unless rights to private property are secure.
    - Governments can aid growth by establishing independent court systems.

]
.panel[.panel-name[Potential GDP]

**Potential GDP**:
- the level of real GDP attained when all firms are operating at capacity 
- **Capacity**: “normal” hours and a “normal” sized workforce.

.pull-left[
**Potential GDP Growth**
- rises when 
  - the labor force expands
  - a nation acquires more capital stock
  - new technologies are created
- Steady growth historically (3.2%)
- 2007-2009 wider gap than usual

]
.pull-right[

]

]
]

---

## Savings, Investment, and the Financial System

.panelset.sideways[
.panel[.panel-name[Intro]
Funding firms' expansion
- Reinvesting profits--but what if you need more?
- **Financial system**: The system of *financial markets* and *financial intermediaries* through which firms acquire funds from households

Financial markets
- **Financial security**: A document (sometimes electronic) stating the terms under which funds pass from the buyer of the security to the seller.
- **Stock**: A financial security representing partial ownership of a firm.
- **Bond**: A financial security promising to repay a fixed amount of funds. A bond is essentially a loan from a household to a firm.

**Financial intermediaries** are firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers.

]
.panel[.panel-name[3 Financial Services]
1. Risk sharing
  - *Risk*: the chance that the value of a financial security will change relative to expecations
  - By allowing investors to spread their money over many different assets, investors can reduce their risk while maintaining a high expected return on their investment.

2. Liquidity
  - *Liquidity*: how easily a security can be exchanged for cash
  - The financial system allows savers to quickly convert their investments into cash.

3. Information
  - *Information*: facts about borrowers and expectations about returns on financial securities
  - The prices of financial securities represent the beliefs of other investors and financial intermediaries about the future revenue stream from holding those securities.
  - This aggregation of information makes funds flow to the right firms.

]
.panel[.panel-name[Investment]
Over the next few slides, let's derive the result that **total saving must equal total investment**

Recall, 
`$$Y = C + I + G + NX$$`

Let's assume a **Closed economy** `$(NX = 0)$`, so 
`$$Y = C + I + G$$`

Now, solve for investment:
$$ I = Y - C - G $$

This means that investment in a *closed economy* is equal to income minus consumption and government purchases

]
.panel[.panel-name[Saving]
**Private vs. Public Saving**
- Private savings `$(S_{private})$`: 
  - household income that is not spent
  - includes payments for factors of production (Y) and transfer payments (TR); households consume (C) and pay taxes (T).
  - `$S_{private} = Y + TR - C - T$`
- Public savings `$(S_{public})$`: 
  - revenue minus expenditures `$(S_{public} = T - G - TR)$`
  - can be negative (**dissaving**)
  - **Balanced budget** `$(T = G + TR)$`
  - **Budget deficit** `$(T < G + TR)$`
  - **Budget surpluses** `$(T > G + TR)$`

Thus total saving is
$$
`\begin{aligned}
S_{total} &= S_{private} + S_{public} \\
S_{total} &= ( Y + TR - C - T) + (T - G - TR) \\
S_{total} &= Y - C - G
\end{aligned}`
$$  
]
.panel[.panel-name[Saving = Investment]
We have:

$$
`\begin{aligned}
I &= Y - C - G \\
S_{total} &= Y - C - G
\end{aligned}`
$$
<br>
<br>
Thus,

$$
S = I
$$

]
.panel[.panel-name[Loanable Funds]

]
.panel[.panel-name[Demand Shock]

]
.panel[.panel-name[Supply Shock]

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.panel[.panel-name[Crowding Out]
**crowding out**: a decline in private expenditure as a result of increases in government purchases

In practice, the effect of government budget deficits and surpluses on the equilibrium interest rate is **relatively small**.

- How small? 
  - According to one study, increasing borrowing by 1% of GDP would increase the real interest rate 0.003 points
- Why would the effect be so small?
  - Interest rates are influenced by *global markets*
  - so even a few hundred billion dollars is a relatively minor amount

]
]

---

## The Business Cycle

.panelset[
.panel[.panel-name[Intro]
.pull-left[
**Real GDP**
- 8-fold increase
- Inconsistent year-to-year

**Business Cycle**
- Alternating periods of expanding and contracting economic activity since 1800s
- These alternating periods are called the *business cycle*

**Stylized Real GDP**
- Rising phases: expansion
- Falling phases: recessions
- Inflection points: peaks/troughs

]
.pull-right[

]
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.panel[.panel-name[Great Recession]
.pull-left[
<img src="data:image/png;base64,#images/tab_10_2.png" width="78%" style="display: block; margin: auto;" />
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.pull-right[
<img src="data:image/png;base64,#images/fig_10_6b.png" width="100%" style="display: block; margin: auto;" />
]
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.panel[.panel-name[Recessions]

**How do we know when the economy is in a recession?**
- Media definition is “two consecutive quarters of declining real GDP”
- It's only a recession if it's from the NBER region of France; otherwise, it's sparkling inflation
- **NBER**: National Bureau of Economic Research (not the Federal goverment)
> “A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.”

**Features of the business cycle:**
1. As expansion ends, interest rates rise and wages rise faster than other prices. (Firm profits are falling)
2. As recession begins, firms decrease their investment spending, and households consume less. (Firms cut back on employment, leading to further declines in spending)
3. Eventually economic conditions improve; firms anticipate the future expansion and begin investing again. (Households do too, and eventually employment recovers)

]

.panel[.panel-name[Inflation]

.pull-left[
The **inflation rate** measures the change in the price level from one year to the next.
- During expansions, demand for products is high relative to supply, resulting in prices increasing—**high inflation**.
- During recessions, demand for products is low relative to supply, resulting in prices increasing more slowly or even decreasing—low inflation or **deflation**.]

.pull-right[
The graph shows the movements in the (CPI) inflation rate over the last two decades.

<img src="data:image/png;base64,#images/fig_10_7.png" width="100%" style="display: block; margin: auto;" />
]

]
.panel[.panel-name[Employment]
.pull-left[
### Unemployment Rate
<img src="data:image/png;base64,#images/fig_10_8.png" width="100%" style="display: block; margin: auto;" />
]
.pull-right[
### Employment and the Great Recession
<img src="data:image/png;base64,#images/fig_10_9.png" width="100%" style="display: block; margin: auto;" />
]
]
.panel[.panel-name[Great Mod]
### Great Moderation
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<img src="data:image/png;base64,#images/fig_10_10.png" width="100%" style="display: block; margin: auto;" />
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.pull-right[
preservef11f207f744d0cf0

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]
.panel[.panel-name[GM Expl.]
**Several factors help to explain the Great Moderation:**

1. **The increasing importance of services**
  - Manufacturing vs. services
2. **The establishment of unemployment insurance**
  - Before the 1930s, no government transfer programs
  - These programs increase the ability of consumers to purchase goods and services during recessions
3. **Active federal government stabilization policies**
  - Government policies to lengthen expansions/minimize recessions
  - Debate over effectiveness of policies
4. **Increased stability of the financial system**
  - Instability of financial system increases severity of recessions
  - e.g. Great Depression (1930s) and recession of 2007-2009
  - Returning to macroeconomic stability requires a stable financial system

]
]

---

## Brief Review
**Long-run growth**
- US experienced long-run economic growth (GDP growth) even though there were shorter periods of expansion contraction
- This means generally increases in labor productivity have led to increases in the standard of living

**How the funds flow from firms to individuals**
- Financial markets vs. financial intermediaries
- Funds available to firms come from saving (private vs. public)
- Saving = Investment
- Market for loanable funds models the interaction between borrowers/lenders that determine the market interest rate and the quantity of loanable funds exchanged

**Business Cycle Effects**
- Inflation rate rises near end of expansion
- Unemployment rate declines during end of expansion
- Future stability debated

---